ALLIENT INC (ALNT) FY 2023 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Amounts presented in Item 7 are in thousands, except per share data.

Overview

We are a global company that designs, manufactures, and sells precision and specialty-controlled motion products and solutions used in a broad range of industries. Our target markets include Industrial, Vehicle, Medical, and Aerospace & Defense (A&D). We are headquartered in Amherst, NY, and have operations in the United States, Canada, Mexico, Europe, and Asia-Pacific. We are known worldwide for our expertise in electro-magnetic, mechanical, and electronic motion technology. We sell component and integrated controlled motion solutions to end customers and OEMs through our own direct sales force and authorized manufacturers’ representatives and distributors. Our products include nano precision positioning systems, servo control systems, motion controllers, digital servo amplifiers and drives, brushless servo, torque, and coreless motors, brush motors, integrated motor-drives, gear motors, gearing, incremental and absolute optical encoders, active (electronic) and passive (magnetic) filters for power quality and harmonic issues, Industrial safety rated input/output Modules, Universal Industrial Communications Gateways, light-weighting technologies, and other controlled motion-related products.

Financial Overview

Highlights for our fiscal year ended December 31, 2023, include:

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We remain focused on executing our strategy for growth while streamlining the organization and emphasizing continuous improvement in quality, delivery, cost and innovation as we drive the One Allient approach and expand our value proposition for our customers. Solid strides continue to be made with our multi-product, fully integrated solutions that are leading to increased business. Also, we continue to build a pipeline of exciting market-based application opportunities. Sales cycles are long and the time from being selected for the solution development to full rate production can be longer, yet we believe we continue to build a scalable foundation which can deliver strong returns on those investments.

Our Strategy

Our growth strategy is focused on becoming a leading global controlled motion solution provider in our selected target markets by further developing our products and services platform to utilize multiple Allient technologies which create increased value solutions for our customers. Our strategy further defines Allient as being a “technology/know-how” driven company and to be successful, we continue to invest in our areas of excellence.

We have set growth targets for our Company and we will focus and align our resources to meet those targets. First and foremost, we invest in our people as we believe that attracting and retaining the right people is the most important element in our strategy. We will continue to invest significantly in applied and design engineering resources.

Our strategic focus is addressing the critical issues that we believe are necessary to meet the stated long-term goals and objectives of the Company. The majority of the critical issues are focused on growth and profitability initiatives for the Company.

One of these initiatives includes product line platform development and rationalization to meet the emerging needs of our target markets. Our platform development emphasizes a combination of our technologies to create increased value solutions for our customers while seeking operating efficiencies. The emphasis on new opportunities has evolved from being an individual component provider to becoming a solutions provider whereby the new opportunities utilize multiple Allient technologies in a system solution approach. We believe this approach will allow us to provide increased value to our customers and improved margins for our Company and are demonstrated in our acquisitions completed in 2023 and 2022. Our strong financial condition, along with AST continuous improvement initiatives in quality, delivery, and cost allow us to have a positive outlook for the continued long-term growth of our Company.

Outlook for 2024

In recent years, we navigated a difficult environment related to the COVID-19 pandemic, while advancing our strategic priorities and delivering solid results. We experienced record orders in 2023, reflecting increases in our Industrial and Vehicle markets. This demand, combined with supply chain constraints, resulted in some inefficiencies and additional costs as our teams worked hard to support and meet customer demand and schedules.

While the economic outlook for 2023 remains uncertain and we expect continued upward pressure on material and labor costs, we believe we are in a strong operational, financial and reputational position. Our record level of backlog, diversified end market penetration and demonstrated agility position us well to perform across varied market trends and

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give us confidence that we can drive further efficiency, profitable growth and increased free cash flow while delivering long-term value for our shareholders.

In 2024, we will focus on leveraging our resources to expand our business in our selected target markets. In addition, we will continue to execute the ongoing critical issues as defined by our Board approved strategy.

The critical issues from that strategy include:

Allient is an applied technology/know-how motion company, and to grow, we will continue to invest in the technical resources to ensure we can move forward with our mantra to “create controlled motion solutions that change the game” and to meet the emerging needs of our customers in our served market segments. We anticipate that our investment in these key resources will continue to drive our growth now and in the future. We expect to continue the shift from being a component supplier to a more complete solutions provider, along with the application of AST, to drive cost reduction.

Our global production footprint provides us with the opportunity to be a value added supplier for global companies who require support around the world. We will continue to evaluate and find areas to leverage our current manufacturing and sales footprint to drive sales and improve efficiencies.

In addition to our strategy described above, time and resources have been spent during 2023 to further understand the ESG ecosystem and developments impacting stakeholder expectations and assess our performance. The Company has a number of initiatives focused on individual components of ESG, and, under the oversight of the Board of Directors, is continuing to integrate ESG with our broader strategy and Enterprise Risk Management (ERM). The strategy will include looking to further enhance the Company’s ability to meet ongoing and emerging challenges, including the impacts of the COVID-19 pandemic.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with Generally Accepted Accounting Principles (“GAAP”). We make estimates and assumptions in the preparation of our consolidated financial statements that affect the reported amounts of assets and liabilities, revenue and expenses and related disclosures of contingent assets and liabilities. We base our estimates and judgments upon historical experience and other factors that are believed to be reasonable under the circumstances. Changes in estimates or assumptions could result in a material adjustment to the consolidated financial statements.

We have identified several critical accounting estimates. An accounting estimate is considered critical if both: (a) the nature of the estimates or assumptions is material due to the levels of subjectivity and judgment involved, and (b) the impact of changes in the estimates and assumptions would have a material effect on the consolidated financial statements. This listing is not a comprehensive list of all of our accounting policies. For further information regarding the application of these and other accounting policies, See Note 1, Business and Summary of Significant Accounting Policies of the notes to consolidated financial statements contained in Item 8 of this report for additional information.

The Company’s critical accounting policies and estimates include:

Revenue Recognition

The Company considers control of most products to transfer at a single point in time when control is transferred to the customer, generally when the products are shipped in accordance with an agreement and/or purchase order. Control is defined as the ability to direct the use of and obtain substantially all of the remaining benefits of the product. The Company satisfies its performance obligations under a contract with a customer by transferring goods and services generally in exchange for monetary consideration from the customer. The Company considers the customer’s purchase

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order, and the Company’s corresponding sales order acknowledgment as the contract with the customer. In the normal course of business, the Company does not accept product returns unless the item is defective as manufactured. The Company establishes provisions for estimated returns and warranties. All contracts include a standard warranty clause to guarantee that the product complies with agreed specifications.

Inventories

Inventories are measured on a first-in, first-out basis at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventory costing requires complex calculations that include assumptions for overhead absorption, scrap, sample calculations, manufacturing yield estimates, costs to sell, and the determination of which costs may be capitalized. The Company’s estimate of the appropriate amount of obsolete or excess inventory, as well as inventory that is not of saleable quality, uses certain inputs and involves judgment. Such inputs include data associated with historic trends, the demand forecast for inventory on-hand which includes customer orders, and item specific estimates about the timing or level of demand for a specific part.

Historically, our inventory adjustment has been adequate to cover our losses. However, variations in methods or assumptions could have a material impact on our results. If our demand forecast for specific products is greater than actual demand and we fail to reduce manufacturing output accordingly, we could be required to record additional inventory write-downs or expense a greater amount of overhead costs, which would negatively impact our net income. As of December 31, 2023, we have $117,686 of inventory recorded on our consolidated balance sheet, representing approximately 20% of total assets. A 1% write-down of our inventory would decrease our 2023 net income by approximately $900, or $0.05 per diluted share.

Evaluation of Goodwill for impairment

We test the reporting unit’s goodwill for impairment as of October 31st of each fiscal year and between annual tests if an event occurs or circumstances change that may indicate that the fair value of the reporting unit is below its carrying value. In conducting this annual impairment test, we may first perform a qualitative assessment of whether it is more-likely-than-not that the reporting unit’s fair value is less than its carrying value. If we determine that it is not more-likely-than-not that the fair value of the reporting unit is less than its carrying amount, no further goodwill impairment testing is required. If it is more-likely-than-not that the reporting unit’s fair value is less than its carrying value, or if we elect not to perform a qualitative assessment of a reporting unit, a quantitative analysis is performed, in which the fair value of the reporting unit is compared to its carrying amount. If the carrying amount of the reporting unit exceeds its fair value, an impairment loss is recognized equal to the excess, limited to the amount of goodwill allocated to that reporting unit.

We performed a qualitative assessment of our single reporting unit as of October 31, 2023. As part of this analysis, we evaluated factors including, but not limited to, our market capitalization and stock price performance, macro-economic conditions, market and industry conditions, cost factors, the competitive environment, and the operational stability and overall financial performance of our reporting unit. The assessment indicated that it was more-likely-than-not that the fair value of our reporting unit exceeded its carrying amount, and as such, a quantitative assessment was not performed.

We do not believe that our reporting unit is at risk for impairment. However, changes to the factors considered above could affect the estimated fair value of our reporting unit and could result in a goodwill impairment charge in a future period. As of December 31, 2023, we have $131,338 of goodwill recorded on our consolidated balance sheet, representing approximately 22% of total assets. A 1% write-down of our goodwill would decrease our 2023 net income by approximately $1,000, or $0.06 per diluted share.

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Business Combinations

The Company allocates the purchase price of an acquired company, including when applicable, the acquisition date fair value of contingent consideration between tangible and intangible assets acquired and liabilities assumed from the acquired business based on their estimated fair values, with the residual of the purchase price recorded as goodwill. Third party appraisal firms and other consultants are engaged to assist management in determining the fair values of certain assets acquired and liabilities assumed. Estimating fair values requires significant judgments, estimates and assumptions, including but not limited to: discount rates, future cash flows and the economic lives of trade names, technology, customer relationships, and property, plant and equipment. These estimates are based on historical experience and information obtained from the management of the acquired companies and are inherently uncertain.

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Impact of Recently Issued Accounting Pronouncements

In the normal course of business, we evaluate all new accounting pronouncements issued by the Financial Accounting Standards Board (“FASB”), Securities and Exchange Commission (“SEC”), Emerging Issues Task Force (“EITF”) or other authoritative accounting bodies to determine the potential impact they may have on our consolidated financial statements. See Note 1, Business and Summary of Significant Accounting Policies of the notes to consolidated financial statements contained in Item 8 of this report for additional information about these recently issued accounting standards and their potential impact on our financial condition or results of operations.

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Operating Results

The following discussion is a comparison between fiscal year 2023 and fiscal year 2022 results. For a discussion of our results of operations for the year ended December 31, 2022 compared to the year ended December 31, 2021, please refer to Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, which was filed with the SEC on March 7, 2023.

Year 2023 compared to 2022

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REVENUES: The increase in revenues in 2023 reflects improved sales in certain markets we serve, specifically Industrial and A&D. The increase reflects the economic recovery and the increases in demand from many of our served markets, as certain markets continued to experience supply chain constraints in the prior year period impacting customer order patterns and lead times. Our sales for 2023 were comprised of 59% to U.S. customers and 41% to customers primarily in Europe, Canada and Asia-Pacific. The overall increase in revenue was due to a 15% volume increase and a minimal foreign currency impact. The acquisitions completed in 2022 and 2023 contributed an incremental $10,057 of revenues in 2023. See information included in “Non – GAAP Measures” below for a discussion of the non-GAAP measure and reconciliation of revenue to revenue excluding foreign currency impacts.

ORDER BOOKINGS AND BACKLOG: The 8% decrease in orders in 2023 compared to 2022 is due to an 8% decrease in volume with minimal foreign currency impact. Decreases in bookings are primarily due to a normalization of customer order patterns as lead times are reducing due to improvement in the global supply chain environment and, to a lesser extent, economic softening in some European markets. The acquisitions completed in 2022 and 2023 contributed an incremental $7,380 of orders in 2023. The decrease in backlog as of December 31, 2023, compared to December 31, 2022 includes incremental backlog of $2,344 from the acquisition that was completed during 2023.

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GROSS PROFIT AND GROSS MARGIN: Gross margins improved to 31.7% for 2023, compared to 31.3% for 2022. The increase in gross margin percentage was largely driven by volume increases of higher margin products primarily in our Industrial and A&D markets combined with pricing and margin accretive acquisitions. The margin expansion continues to be muted, to some extent, by the continued increases in material and labor costs..

SELLING EXPENSES: Selling expenses increased 13% during 2023 compared to 2022 primarily due to sales commissions related to the revenue growth as well as increased costs in connection with our acquisitions. Selling expenses as a percentage of revenues were comparable at 4% during 2023 and 2022.

GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses increased by 15% during 2023 compared to 2022 due primarily to incentive compensation-related expenses due to current year Company performance and increased costs in connection with our acquisitions. As a percentage of revenues, general and administrative expenses were comparable at 10% in both 2023 and 2022.

ENGINEERING AND DEVELOPMENT EXPENSES: Engineering and development expenses increased by 8% in 2023 compared to 2022. The increase is primarily due to the continued ramp up of development projects to meet the future needs of target markets and supporting growing customer application development needs, as well as increased costs in connection with our acquisitions. As a percentage of revenues, engineering and development expenses were 7% and 8% for the years ended December 31, 2023 and 2022, respectively.

BUSINESS DEVELOPMENT COSTS: The increase in business development costs in 2023 compared to 2022 is largely due to fair value changes of contingent consideration of $1.9 million related to acquisitions, manufacturing footprint rationalization, and costs incurred due to current period acquisition activities, offset by lower acquisition-related costs in 2023.

AMORTIZATION OF INTANGIBLE ASSETS: Amortization of intangible assets increased 10% in 2023 compared to 2022, due to the inclusion of the full year of intangible asset amortization of the 2022 acquisitions and, to a lesser extent, the incremental intangible asset amortization from the 2023 acquisition.

INTEREST EXPENSE: Interest expense increased by 61% in 2023 compared to 2022 primarily due to higher interest rates, offset in part by the impact of interest rate swaps.

INCOME TAXES: For 2023 and 2022, the effective income tax rate was 18.9% and 26.6%, respectively. The effective rate differs from the statutory rate primarily due to state income taxes, the impact of foreign tax provisions in the U.S., foreign tax rate differences, Section 162(m) compensation limits, and the benefit of Research and Development tax credits and incentives. The effective tax rate for 2023 was lower than the effective tax rate for 2022 primarily due to increases in certain credits and incentives, the realization of certain deferred income tax assets that had been reserved in prior years, as well as the impact of the mix of foreign and domestic income.

NET INCOME AND ADJUSTED NET INCOME: Net income increased during 2023 compared to 2022, primarily due to operating income increases, reflecting increased revenues and higher gross margin, partially offset by an increase in operating expenses and interest expense.

Adjusted net income for the years ended December 31, 2023 and 2022 was $37,458 and $29,971, respectively. Adjusted diluted earnings per share for 2023 and 2022 were $2.30 and $1.88, respectively. Adjusted net income and adjusted diluted earnings per share are non-GAAP measures. See information included in “Non–GAAP Measures” below for a discussion of the non-GAAP measure and reconciliation of net income to Adjusted net income and diluted earnings per share to Adjusted diluted earnings per share.

EBITDA AND ADJUSTED EBITDA: EBITDA was $67,151 for 2023 compared to $56,859 for 2022. Adjusted EBITDA was $77,184 and $65,549 for 2023 and 2022, respectively. EBITDA and Adjusted EBITDA are non-GAAP measures. EBITDA consists of income before interest expense, provision for income taxes, and depreciation and amortization. Adjusted EBITDA also excludes stock-based compensation expense, foreign currency gain/loss and certain other items. Refer to information included in “Non-GAAP Measures” below for a discussion of the non-GAAP measure and a reconciliation of net income to EBITDA and Adjusted EBITDA.

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Non-GAAP Measures

Organic growth, EBITDA, Adjusted EBITDA, Adjusted net income and Adjusted diluted earnings per share are provided for information purposes only and are not measures of financial performance under GAAP.

Management believes the presentation of these financial measures reflecting non-GAAP adjustments provides important supplemental information to investors and other users of our financial statements in evaluating the operating results of the Company as distinct from results that include items that are not indicative of ongoing operating results. In particular, those charges and credits that are not directly related to operating unit performance, and that are not a helpful measure of the performance of our underlying business particularly in light of their unpredictable nature. These non-GAAP disclosures have limitations as analytical tools, should not be viewed as a substitute for revenue and net income determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. In addition, supplemental presentation should not be construed as an inference that the Company’s future results will be unaffected by similar adjustments to net income determined in accordance with GAAP.

The Company believes that revenue excluding foreign currency exchange impacts is a useful measure in analyzing sales results. The Company excludes the effect of currency translation from revenue for this measure because currency translation is not under management’s control, is subject to volatility and can obscure underlying business trends. The portion of revenue attributable to currency translation is calculated as the difference between the current period revenue and the current period revenue after applying foreign exchange rates from the prior period.

The Company believes EBITDA is often a useful measure of a Company’s operating performance and is a significant basis used by the Company’s management to measure the operating performance of the Company’s business because EBITDA excludes charges for depreciation, amortization and interest expense that have resulted from our debt financings, acquisitions, as well as our provision for income tax expense. EBITDA is frequently used as one of the bases for comparing businesses in the Company’s industry.

The Company also believes that Adjusted EBITDA provides helpful information about the operating performance of its business. Adjusted EBITDA excludes stock-based compensation expense, as well as business development costs, foreign currency gains/losses on short-term assets and liabilities, and other items that are not indicative of the Company’s core operating performance. EBITDA and Adjusted EBITDA do not represent and should not be considered as an alternative to net income, operating income, net cash provided by operating activities or any other measure for determining operating performance or liquidity that is calculated in accordance with GAAP.

Management uses Adjusted net income and Adjusted diluted earnings per share to assess the Company’s consolidated financial and operating performance. Adjusted net income and Adjusted diluted earnings per share are provided for informational purposes only and are not a measure of financial performance under GAAP. These measures help management make decisions that are expected to facilitate meeting current financial goals as well as achieving optimal financial performance. Adjusted net income provides management with a measure of financial performance of the Company based on operational factors as it removes the impact of certain non-routine items from the Company’s operating results. Adjusted diluted earnings per share provides management with an indication of how Adjusted net income would be reflected on a per share basis for comparison to the GAAP diluted earnings per share measure. Adjusted net income is a key metric used by senior management and the Company’s Board of Directors to review the consolidated financial performance of the business. This measure adjusts net income determined in accordance with GAAP to reflect changes in financial results associated with the highlighted expense and income items. Organic growth is reported revenues adjusted for the impact of foreign currency and the revenue contribution from acquisitions.

The Company’s calculation of organic growth for 2023 is as follows:

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The Company’s calculation of EBITDA and Adjusted EBITDA for 2023 and 2022 is as follows (in thousands):

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The Company’s calculation of Adjusted net income and Adjusted diluted earnings per share for years ended December 31, 2023 and 2022 is as follows (in thousands, except per share data):

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Liquidity and Capital Resources

The Company’s liquidity position as measured by cash and cash equivalents increased by $1,287 to a balance of $31,901 at December 31, 2023 from 2022.

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Of the $31,901 cash and cash equivalents on hand at December 31, 2023, $20,704 was located at our foreign subsidiaries and may be subject to withholding tax if repatriated to the U.S.

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During 2023, the cash provided by operating activities increased from 2022 primarily due to increases in net income, adjusted for non-cash items, as well as improvements in working capital, most notably receivables and inventories, due to improvement in 2023 of supply chains as inventories had been significantly impacted by supply chain disruptions during 2022.

The cash used in investing activities in 2023 decreased as compared with 2022, due to less acquisition activity and, to a lesser extent, timing of capital expenditures. The Company expects 2024 capital expenditures to be approximately $16,000 to $20,000.

Cash used in financing activities in 2023 as compared to cash provided from financing activities in 2022 reflects the increase in debt payments made during 2023 due to cash generated from operations, as well as lower debt borrowings due to less acquisition activity as compared to 2022. The 2023 activity includes Amended Revolving Facility borrowings of $7,000 to fund business acquisition activity in the third quarter of 2023, as compared to the $71,000 to fund the three acquisitions in the second quarter of 2022 and, to a lesser extent, inventory requirements during uncertain supply chain environments in 2022. Debt payments of $28,395 and $7,585 were made during 2023 and 2022, respectively. At December 31, 2023, the Company had $210,120 of obligations under the Amended Revolving Facility, excluding deferred financing costs.

The Amended Credit Agreement includes covenants and restrictions that limit the Company’s ability to incur additional indebtedness, make certain investments, create, incur or assume certain liens, merge, consolidate or sell all or substantially all of its assets and enter into transactions with an affiliate of the Company on other than an arms’ length transaction. These covenants, which are described more fully in the Amended Credit Agreement, to which reference is made for a complete statement of the covenants, are subject to certain exceptions.  The Amended Credit Agreement contains financial covenants that require that the Company maintain a minimum interest coverage ratio of at least 3.0 to 1.0 at the end of each fiscal quarter. In addition, the Company’s Leverage Ratio at the end of any fiscal quarter shall not be greater than 3.5 to 1.0 ratio; provided that the Company may elect to temporarily increase the Leverage Ratio by 0.5x during the twelve-month period following a material acquisition under the Amended Credit Agreement (“acquisition leverage increase”), subject to certain exceptions.  The Company was in compliance with all covenants at December 31, 2023 as well as at each quarter end during 2023.

As of December 31, 2023, the unused Amended Revolving Facility was $69,880. The amount available to borrow may be lower and may vary from period to period based upon our debt and EBITDA levels, which impacts our covenant calculations. The Amended Credit Agreement matures in February 2025.

There were no borrowings under the China Facility during 2023 or 2022. The Company closed the China Facility during 2023.

The Company declared dividends, in total, of $0.115 and $0.10 per share during 2023 and 2022, respectively. The Company’s working capital, capital expenditure and dividend requirements are expected to be funded from cash provided by operations and amounts available under the Amended Credit Agreement (refer to Note 7, Debt Obligations, of the notes to consolidated financial statements for definition and terms).

We believe our diverse markets, our strong market position in many of our businesses, and the steps we have taken to strengthen our balance sheet, such as retaining cash to support shorter term needs and amending our revolving credit facility leaves us well-positioned to manage our business. We continually assess our liquidity and cash positions taking geopolitical and other uncertainties into consideration. Based on our analysis, we believe our existing balances of cash, our currently anticipated operating cash flows, and our available financing under agreements in place will be more than sufficient to meet our cash needs arising in the ordinary course of business for the next twelve months.

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